The Long and Short (Run) of Trade Elasticities

Abstract

We propose a novel approach to estimate the trade elasticity at various horizons. When large countries change Most Favored Nation (MFN) tariffs, small trading partners that are not in a preferential trade agreement experience plausibly exogenous tariff changes. The differential growth rates of imports from these countries relative to a control group — countries not subject to the MFN tariff scheme — can be used to identify the trade elasticity. We build a panel dataset combining information on product-level tariffs and trade flows covering 1995-2017, and estimate the trade elasticity at short and long horizons using local projections (Jorda, 2005). Our main findings are that the elasticity of tariff-exclusive trade flows in the year following the exogenous tariff change is about –0.7, and the long-run elasticity ranges from –1.5 to –2. The welfare-relevant long-run trade elasticity is about –0.6. Our long-run estimates are smaller than typical in the literature, and it takes 7-10 years to converge to the long run, implying that (i) the welfare gains from trade are high and (ii) there are substantial market penetration costs to accessing new customers.